Japan-China Trade Constrains Abe in Territorial Disputes

Japanese Prime Minister Shinzo Abe is taking a hard line in the nation’s territorial disputes with China. But there’s one factor constraining his room for action: the increasing importance of China for Japanese businesses.

Consider the figures.

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China is Japan’s largest export market and Japan’s direct investment in China was $13.48 billion in 2012, or 11% of its total investment abroad. Many Japanese companies use China as a cheaper offshore production base. Others, like Honda Motor Co. and Toyota Motor Corp., set up factories there to be near China’s massive consumer market.

For some Japanese, Mr. Abe’s new muscular approach in dealing with China is exasperating.
“Japan and China are trade partners that can’t do without each other,” Nomura Securities chief executive Koji Nagai said recently. “Frankly, I wish (the administration) would deal with matters more suitably.”

Since coming to power a year ago, Mr. Abe has upped the rhetoric with China over territorial disputes. Last month, he visited a shrine that honors Japan’s war dead, including some convicted war criminals from World War II, a move that enraged Beijing.

Mr. Abe denied the visit was aimed at escalating tensions with China. Yet Beijing has been wary of Mr. Abe, who says revising Japan’s U.S.-drafted pacifist constitution is his “life work” and has sought for Japan’s military to play a greater role in regional security.

Given the economic realities, though, an escalation in hostilities seems an unlikely outcome for now.
“Never in the history of Japan-China relations have the two been so deeply mutually dependent economically,” former Japanese ambassador to China, Yuji Miyamoto, told public broadcaster NHK last week. “We’re living in a global economy in which we both need each other. So a war is an option that we can’t turn to.”

Times have changed since former Japanese Prime Minister Junichiro Koizumi made annual visits to the Yasukuni Shrine from 2001, arguing that other nations had no business in how Japanese leaders paid respects to the nation’s war dead.

At that time, China was still a distant second after the U.S. as a market for Japanese goods, and Japan’s investment in the Asian neighbor was only 5% of its total investment abroad.

To see what’s at stake for Japan, consider the developments in the fall of 2012 after Japan nationalized a series of East China Sea islands contested by the two countries.

The move led to anti-Japanese street protests in China, with some Japanese retailers suffering damages to their stores and even attacks on Japanese-brand cars and their drivers.

As a result, Japanese carmakers’ share of China’s auto market fell to below 15% by the end of 2012 from 20% before the tensions. Chinese tourists cancelled trips to Japan, resulting in a nearly 50% year-on-year drop in arrivals in some months after the flare up over the islands.

Beijing, too, has reasons not to allow a repeat of the 2012 violence. Japan is one of the largest foreign investors in China, accounting in 2012 for 7% of incoming foreign direct investment.
Some observers say China is acting in a more restrained fashion.

“It hasn’t used the economics card this time,” said Tatsuhiko Yoshizaki, chief economist at Tokyo-based Sojitz Research Institute.

For now, Japan Inc. has been muted in its criticism, reluctant to blame Mr. Abe of any wrongdoing as they have been beneficiaries of “Abenomics”—the prime minister’s policy mix of powerful monetary and fiscal stimulus that has pushed down the yen, boosted stock prices and improved earnings.

But that could change if relations get more heated. “Of course, we’re watching very closely,” said Toshiyuki Shiga, vice chairman of Nissan Motor Co, which has the biggest presence in China among Japanese auto makers. “After all, this kind of problem will have an impact on business.”

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